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India's Goods and Service Tax: the Case for Distribution Network Redesign


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A comparison analysis of cost scenarios for India's distribution network in the context of the GST (Goods and Service Tax) and including VAT (Value Added Tax) and CST (Central Sales Tax), showcasing the new benefits of centralized warehousing at reducing total logistics costs.

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India's Goods and Service Tax: the Case for Distribution Network Redesign

  1. 1. • Cognizant 20-20 InsightsIndia’s Goods and Service Tax: the Casefor Distribution Network Redesign Executive Summary tal way because it impacts so many areas of the business. For example, some of the options Fiscal costs have remained a key determinant of around redesigning the supply chain would relate supply chains in India, with manufacturing bases to the following: and distribution networks engineered to harness fiscal benefits. The availability of differential tax • Indigenous supplies vs. imports. structures across geographies has remained one of the key decisional elements for structuring the • Intrastate or interstate procurement of goods and services. supply chains, procurement patterns and distri- bution networks in India. With that consideration, • Manufacturing and warehousing locations. the Goods and Service Tax (GST) stands as an • In-house or contract manufacturing. inflexion point in India’s fiscal landscape. It marks the transition from an existing origin-based • Direct sale vs. stock transfers. taxation regime to a destination-based taxation Warehousing changes can be taken as a case in regime. The introduction of GST is expected to point here to understand the impact that GST remove the cascading effect of taxes by moving may have on supply chains and other elements to a common tax base and subsuming various of business. state and central taxes into Central Goods and Service Tax (CGST) and State Goods and Service What Defines Warehouse Location? Tax (SGST). The introduction of such a common Warehouses are an important part of any supply tax structure will significantly impact the pro- chain. A strategically placed warehouse not curement patterns, supply chains and distribu- only improves customer service levels but also tion networks of manufacturing firms. This will reduces the burden on other elements of a supply present both opportunities and challenges for chain. In India, apart from other criteria such as firms doing business in India. customer service levels, freight costs, etc., the dif- ferential state and central taxes levied on sales of One of the opportunities is to make the supply goods largely affects the location of a warehouse. chain leaner, but the challenge lies in actually To understand this, we will use a typical supply doing it. Optimizing the supply chain entails chain setup as shown below. relooking at the business model in a fundamen- cognizant 20-20 insights | march 2012
  2. 2. Typical Supply Chain Firm Warehouse/ Distributor Retailer Customer Depot Figure 1 Current State goods to the warehouse before actually selling it to the distributor in that state. According to Let’s look at two scenarios that show how a current tax laws, this transfer carries no central consumer goods (CG) manufacturer sells its sales tax (CST) since no sale has been realized. goods to a distributor and how that impacts the In this case, the value added tax (VAT) is applied location of the warehouse in a non-GST environ- only after a sale is made to a distributor using the ment. The “input tax credit” at the source and warehouse. Also, the VAT paid by the distributor the logistics costs in landed cost component have to buy from the warehouse is used as an “input been ignored for simplicity. tax credit” bringing down the “price before tax” Scenario A: Stock Transfer Sale of the goods for retailers. A sample calculation is shown below for understanding. Let’s assume a firm operates a warehouse in another state and does a stock transfer of its Current State: Stock Transfer Sale Supply Landed Input VAT Price Total Tax Final3 Cost Margin Credit Before Tax (CST+VAT) Price Chain VAT CST (in `) Point (in `) (in `) (in `) (in `) (in `) Firm 200 50 0 250 0% 0% 0 250 Warehouse 250 0 0 250 4% 0% 10 260 Distributor 260 20 10 270 4% 0% 10.8 280.8 Retailer 280.8 15 10.8 285 4% 0% 11.4 296.4 Scenario B: CST sales to Distributor– case, the firm pays CST on this interstate sale. Let’s assume the firm decides to sell its goods The rest of the transactions in the supply chain directly to the distributor located in another state remain the same. Now the calculations look as without holding a warehouse in that state. In this shown below. Current State: CST Sales to Distributor Supply Landed Input VAT Price Total Tax Final Chain Margin Cost Credit Before Tax VAT CST (CST+VAT) Price Point (in `) (in `) (in `) (in `) (in `) (in `) Firm 200 50 0 250 0% 2% 5 255 Warehouse 0 0 0 0 0% 0% 0 0 Distributor 255 20 0 275 4% 0% 11 286 Retailer 286 15 11 290 4% 0% 11.6 301.6 cognizant 20-20 insights 2
  3. 3. In scenario two the final price (`301.6) for the ly located warehouses, the firms focus on savingconsumer increases in comparison to the final their margins. The above scenarios also show whyprice (`296.4) paid by consumer in the first most businesses would prefer to source locallyscenario. To maintain the same price (MRP) for and not through interstate purchases.the end consumer, the firm has to take a hit onits margins so that the distributor and retailer Future Statemargins are preserved. This happens because With the introduction of GST, the tax barrier onunlike VAT, CST cannot be claimed as an “input cross-border sales will be removed. The tax disin-tax credit.” So, when the distributor adds its own centive of cross-border sales due to the presencemargin to an already high landed cost, the total of CST will be eliminated. There can be twocost for the retailer increases. Since the distrib- scenarios by which the government can achieveutor will not like to give the same product at a this task.higher price to the retailer, the firm has to take ahit on the margin. Scenario A: Complete Elimination of CST Charged on Interstate SalesThe above two scenarios clearly show that dis- In this case a firm can sell directly to the distribu-tributors will like to buy from a warehouse in tor in another state without paying the CST. Thethe same state rather than buying directly from calculations shown below verify that this wouldthe firm in another state. This type of provision not lead to any loss of margin for the firm andin the current tax structure has forced firms to distributors and retailers can enjoy their sharelocate warehouses in all the states where they of margins without increasing the final price ofdo business. Instead of focusing on supply chain goods.efficiency that can be generated from strategical-Future State: Eliminate CST Charged on Interstate Sales Supply Landed Margin Input Tax Price Before Total Tax Final Price GST Chain Point Cost (in `) (in `) Credit (in `) Tax (in `) (in `) (in `) Firm 200 50 0 250 0% 0 250 Warehouse 0 0 0 0 0% 0 0 Distributor 250 20 0 270 4% 10.8 280.8 Retailer 280.8 15 10.8 285 4% 11.4 296.4Scenario B: Elimination of CST But Interstate subsequent sale. Even in this case the marginsSale or Transfer Is Charged with Provision of for companies, distributors and retailers areInput Credit maintained without affecting the final price forLet’s assume that CST is abolished and interstate the consumer. This is depicted in the calculationssale is taxed with input credit allowed on the below.Future State: Eliminate CST but Charge Interstate Sale or Transfer Supply Chain Landed Margin Input Tax Price Before Total Tax Final Price GST Point Cost (in `) (in `) Credit (in `) Tax (in `) (in `) (in `) Firm 200 50 0 250 4% 10 260 Warehouse 0 0 0 0 0% 0 0 Distributor 260 20 10 270 4% 10.8 280.8 Retailer 280.8 15 10.8 285 4% 11.4 296.4The scenarios below clearly show that with the placed warehouses. The supply chain networkadvent of GST, having a warehouse in every state can be made leaner and smarter so that thewhere a firm does business will no longer remain operational costs are minimized and efficiencya necessity. The supply chain can be designed is improved. With the provision of the input taxpurely on logistics costs and customer service credit, each tax point in the supply chain will beconsiderations and not on tax considerations. The required to record, maintain and file tax transac-firms can now have fewer and more strategically tions happening at that point. It is probably fair to cognizant 20-20 insights 3
  4. 4. suggest that the longer the supply chain, the more inefficiencies creeping into the system with thethe tax points in the GST scheme of things and presence of many smaller stocking points. Thehence increased compliance costs. The challenge logistics and inventory carrying cost of goods areand the opportunity is thus to compress supply very high as firms carry more inventory to fulfillchains for GST efficiency while ensuring that the demand and are handcuffed in selling productsbusiness objectives in and around supply chains across states. The tax regime has also provedare also met. detrimental to the development of 3PL and 4PL providers in India, adding to the logistics woes ofGST Impact on Warehousing the country. India has one of the highest logisticsIn today’s context, a firm spends large sums of cost as a ratio of GDP (see Figure 2) compared tomoney in managing different warehouses to other countries of the world. Also, transportation,overcome the fiscal regime. The presence of these inventory and warehousing contributes up to theduplicate entities in the supply chain has added 70% of the total spend on logistics in India. All ofto the additional cost of administration, utility these costs are in some way impacted by a dif-services and technology required to manage ferential tax regime which promotes smaller andthese entities. The effect on cost of goods sold multiple stocking points.(COGS) is further pronounced due to productivityCross Country Logistics Cost Comparison Logistics Activities by 3PL/ Country Elements of Logistics Cost1 Cost/GDP Logistics Activities India, China 16-20% <10% 9% 6% Transportation US 9-10% 60% 11% 35% Inventory Europe 10% 30-40% 14% Losses Packaging Japan 11% 80% 25% Warehousing Customer’s ShoppingFigure 2From a technology perspective, the implemen- First of all, fewer and larger warehouses may maketation of ERP at multiple warehouses is a costly it feasible to route plant production directly toaffair, so most small to medium businesses in warehouses rather than through hubs. Thus, theIndia have stayed away from technology imple- size and number of hubs could be affected. Whilementations that can result in long-term profits. consolidating the warehouses, the optimum pathThis has resulted in the proliferation of myriad for moving current inventory to the newly locatedtechnology implementations in warehouses warehouses has to be worked out to reduceand increased technology spends by firms. The the cost of manufactured goods movement. Annon-standardized modus operandi in these increase in inventory movement cost may impactwarehouses also hampers the ability to bring the price of goods directly. Once the firm decidesefficiency in people-related processes. There are to move to fewer warehouses, the overall COGSmany more such inefficiencies that Indian firms will come down. At current price levels, this willare living with due to the differential tax regime. entail more profits for the firm, and passing onIn a GST frame of things, logistics costs and not this benefit to consumers will positively affect thetax considerations will play an important role in demand for products.determining the location of a warehouse. Firmswill move towards fewer and more strategically With increasing demand for products and services,located warehouses and this will entail combining the demand planning and management at newlythe existing capacities of warehouses or creating constructed or consolidated warehouses will havenew capacities. As simple as it sounds, the firm to be reevaluated. Even if the demand planninghas to prepare for various impacts and challenges is perfected, the logistics costs associated withthat this may bring. delivery of goods will change. Firms have to cognizant 20-20 insights 4
  5. 5. look for new optimization techniques which can served in answering the following questionshelp them keep the current service levels and before embarking on such a on logistics costs. To maintain the currentlead time with fewer warehouses, the firm has • What aspects of business, technology and people will get impacted?to redesign the network by factoring in variousparameters that affect lead time. GST will foster • How to make sure that the future state fulfillsgrowth of 3PL and 4PL providers, and firms will the current business objectives as well?have to consider their services while designing • What external factors should one include inthe distribution networks of the future. Fewer and doing such an analysis?larger warehouses may even encourage adoptionof cross docking that can alter the way products • Once impacts are identified, how to drive them to their rightful conclusion in the organization?are handled in the warehouse. Advent of GSTmay even change the customer perception about Even though the impacts of GST on a firm’sa firm’s products. As the footprint (in terms of business are numerous, a methodical approachwarehousing) required for operating in the Indian can help in identifying and preparing for suchmarket will shrink, more foreign companies will challenges. Once the impacts are identified andenter the market to do business. The competition core business objectives are known, the firm canamong foreign and national players will intensify, use inputs from such an exercise to define andresulting in an upsurge in customers’ demand for redesign the future distribution system.high quality. Approach to Network RedesignA thorough look at various aspects of a firm shows It’s quite evident by now that firms in India havethat the impact of warehousing changes needs to to consolidate their warehouses and redesign thebe accessed not just from a supply chain perspec- distribution network to remain competitive andtives but also from technology and people per- efficient with the advent of GST. As easy as it mayspectives. IT systems would need to be migrated, sound, the impacts of such a process are manifoldaligned and upscaled for a robust performance in and ignoring any one of them may be detrimen-the new world of larger warehouses. With fewer tal for the distribution network and, in turn, forwarehouses to worry about, firms will be eager the firm. A company needs to follow a methodicalto implement ERP solutions to achieve greater approach for carrying out impact analysis onefficiencies in operations. To enjoy economies of current supply chain points. Once such an analysisscale, the firms need to move towards fewer tech- is done, a holistic solution can be built by keepingnologies and better application rationalization. in mind the business, people and technologyIncreasing scarcity of skilled labor and skyrock- aspects of changes. The “DOT Framework” caneting real estate prices will force firms to go for help firms navigate through such challenges andautomated, efficient and vertical warehouses. The redesign their distribution networks. The variousadoption of intelligent warehouse management phases, activities and output of each phase aresystems and innovative technology (e.g., iPad shown in Figure 3.applications for managing shelves and SKUs ina big warehouse) to reduce human effort will The three phases of this approach help in the qual-increase greatly. People will have to be retrained itative and quantitative assessment of differentin various operating procedures of the firm and aspects of a distribution network. At each pointcustomer care has to be reevaluated during the of assessment it is ensured that new design notinitial days of transition to new warehouses. only satisfies current business objectives but alsoOrganizations will have to undertake customer generates a feedback mechanism for continuouseducation initiatives to help them understand improvement. The broad objectives of these threevarious changes brought about by GST. These phases are as follows:changes will in turn alter the ways in whichbusinesses are run. • Discover: This phase helps in understand- ing a firm’s business, the external environ-Moving different pieces of an existing supply ment in which it operates and its capacity tochain, which has been perfected after several make changes. Since each firm is unique inyears of experience and optimization, seems itself, this phase is a cornerstone for the otherto be a daunting task. Changes to a warehous- phases and defines the future course of actioning network impact both tangible and intangible in a redesigning exercise. Another goal of thisaspects of a business. And a firm will be better phase is to derive insights into current supply cognizant 20-20 insights 5
  6. 6. DOT Framework – Redesigning the Distribution Network Activity Outcome • Understand firm’s business requirements and vision. • Requirement & Scope Analysis • Gain insight into firm’s competition, vendors and consumers. • Competition Analysis • Identify firm’s readiness for change and key stakeholders. • Industry Analysis • Classify KPI/KPA and success factors that a firm identifies with its distribution network. • Success Matrices • Stakeholder Analysis 5 Weeks Discover • Benchmark success factors against industry best practices. • Workshop Plan and Mind Maps • Organize workshops to analyze: • Demand & Forecasting Analysis > Demand patterns, forecasting strategy and inventory management techniques used. • AS-IS Distribution Network > Customer SLAs and associated delivery (logistics) mechanisms in place. Analysis > Warehouse management techniques and supporting technology employed. • Customer Analysis > Criticality of a stocking point in supply chain with respect to distribution, • Skill Assessment taxation and capacity. • Training Assessment • Ascertain firm’s business processes affected by redesigning the distribution network. • TO-BE Distribution 8 Weeks • Build redesigned & optimized distribution network using inputs from first phase. Network Blueprint • Generate rigorous “what-if” scenarios and network performance matrices. • “What-if“ Scenarios Optimize • Create business process impact matrices and redesign process flows. • Impact Analysis • Identify risk and associated mitigation plan to keep project on track. • Risk and Mitigation Analysis • Create implementation road map and key metrics to measure performance. • Complete Implementation • Produce detailed customer care and employee training manuals. Road Map • Training Manuals • Carry out necessary process & technology changes in accordance with implementation 4 Weeks road map and redesigned distribution network blueprint. • Simulation Analysis • Run simulations on “what-if” scenarios and create performance matrices. • Training Feedback Transform • Execute change management process. • Learning Document • Implement user training and customer awareness programs. • Change Management Analysis • Monitor adoption & measure KPI/success factors continuously to ascertain • Performance Matrices solution effectiveness. • Adoption Matrices • Perform market scan/survey to identify effect on competition, customer • ROI Document SLAs and firm’s performance. • Market Scan Analysis • Fine-tune solution using market scan and KPI data.Figure 3 chain strategy and supporting processes. The leads to further fine-tuning of the distribu- aim is to highlight shortcomings, strengths and tion network. The new network is continuously areas of improvement in the existing distribu- benchmarked against best practices to gain tion network to better fulfill the future needs. efficiency.• Optimize: The objective here is to create a Conclusion blueprint of the future distribution network while keeping in mind factors such as efficiency, A common tax structure for goods and services scalability and flexibility. Various parameters in India is necessary for improving supply chain and “what-if” scenarios that characterize a dis- efficiencies and rationalizing business objectives. tribution network’s effectiveness are defined in The only question that needs to be answered this phase. No stone is left unturned in defining is when this will become a reality. Whenever it the future processes that will lead to employee happens, it will come with a set of challenges that and customer satisfaction. In short, the entire if addressed at the right time can take businesses road map that defines the future state is built to new heights. Our strong consulting expertise in here. the areas of supply chain sourcing, planning and execution can help firms in moving forward with• Transform: The intention here is to bring new confidence and embracing GST with ease. We can business processes in practice and redesign help with every aspect of distribution network the distribution network according to the redesign, from analyzing the existing supply implementation road map. This phase may chain points to designing an optimized network involve shadowed phase-out, upgrade or to implementing the new model. We also have replacement of current distribution network vast experience in streamlining IT processes and pieces. This phase also characterizes testing creating future IT road maps for consumer goods of “what-if” scenarios, measuring various KPIs firms. Our delivery model ensures that all three and executing change management processes. aspects — process, people and technology — are Transformation is accompanied by the creation honored while driving change in the firm. of a continuous feedback mechanism that cognizant 20-20 insights 6
  7. 7. Footnote1 The Indian Logistics Industry — 2006, N. Viswanadham, Center for Global Logistics and Manufacturing Strategies, Indian School of Business.References1. “GST Reforms and Intergovernmental Considerations in India,” March 2009, Department of Economic Affairs, Ministry of Finance, Government of India.2. “Goods and Service Tax: An Introductory Study,” April 2007, Sudhir Halakhandi, The Charted Accountant.3. “How GST impacts Your Business,” 2010, Ernst & Young.4. “Understanding GST,” 2010, Ernst & Young.5. “The IT Strategy for GST,” July 2010, Nandan Nilekani, Empowered Group on IT Infrastructure on GST, Government of India.6. “GST Alert: India Update,” Dec 2009, KPMG.7. “Supply Chain & GST,” Sept 2009, PriceWaterhouseCoopers.8. “GST: Impact on Supply Chain,” Anil Rajpal, Sachin Jagtap, Technopack Consulting.9. “Supply Chains of Asia: Challenges & Opportunities,” 2002, Accenture.About the AuthorsChandrasekar Ranganathan is a Manager in the Consulting Group. Chandrasekar has over 17years of experience with over 12 years in business/IT consulting including seven years of project/delivery management. Some of Chandrasekar’s consulting assignments include business processreengineering, SAP and SOx solutions, business case validation for supply chain redesign, ITstrategy and road maps for M&A, and business transformation planning. He has completed a cer-tification program in global business leadership offered by U21 Global. He can be reached Jain is a Senior Consultant currently working in the Consumer Goods Department of CognizantBusiness Consulting group. Jiten has expertise in claims and rebate management, order managementand trade promotion management with an emphasis on supply chain planning and execution. He hasconsulted for Fortune 500 consumer goods and manufacturing clients in business blueprinting, businessprocess reengineering, requirement analysis, portfolio rationalization and project execution. Jiten hasan MBA in information management from the S. P. Jain Institute of Management and Research, Mumbaiand a Bachelor of Engineering in computers from South Gujarat University. He can be reached CognizantCognizant (NASDAQ: CTSH) is a leading provider of information technology, consulting, and business process out-sourcing services, dedicated to helping the world’s leading companies build stronger businesses. Headquartered inTeaneck, New Jersey (U.S.), Cognizant combines a passion for client satisfaction, technology innovation, deep industryand business process expertise, and a global, collaborative workforce that embodies the future of work. With over 50delivery centers worldwide and approximately 137,700 employees as of December 31, 2011, Cognizant is a member ofthe NASDAQ-100, the S&P 500, the Forbes Global 2000, and the Fortune 500 and is ranked among the top performingand fastest growing companies in the world. Visit us online at or follow us on Twitter: Cognizant. World Headquarters European Headquarters India Operations Headquarters 500 Frank W. Burr Blvd. 1 Kingdom Street #5/535, Old Mahabalipuram Road Teaneck, NJ 07666 USA Paddington Central Okkiyam Pettai, Thoraipakkam Phone: +1 201 801 0233 London W2 6BD Chennai, 600 096 India Fax: +1 201 801 0243 Phone: +44 (0) 20 7297 7600 Phone: +91 (0) 44 4209 6000 Toll Free: +1 888 937 3277 Fax: +44 (0) 20 7121 0102 Fax: +91 (0) 44 4209 6060 Email: Email: Email:©­­ Copyright 2012, Cognizant. All rights reserved. No part of this document may be reproduced, stored in a retrieval system, transmitted in any form or by anymeans, electronic, mechanical, photocopying, recording, or otherwise, without the express written permission from Cognizant. The information contained herein issubject to change without notice. All other trademarks mentioned herein are the property of their respective owners.